© iStockphoto/alexeys Fallen angels, rising stars Old LatAm basins creating fresh opportunities Oil & gas sector October 2013 Published by Edison Investment Research Fallen angels, rising stars Old LatAm basins creating fresh opportunities 10 October 2013 A new production trend has been emerging in Latin America. Smaller independent E&P companies have significantly contributed to increased Companies profiled in this report production levels in Colombia, with similar results possible in Argentina, Americas Petrogas (BOE) Peru, Paraguay and Trinidad. In this report we introduce three valuation Amerisur Resources (AMER) screens based on cash flow, market value and risk, from which we Canacol Energy (CNE) segment our universe of 18 independent oil companies. Our top picks for Crown Point Energy (CWV) the region are GeoPark, Americas Petrogas, Madalena, Canacol, GeoPark (GPK) Petroamerica and Suroco. Also seen as high potential but slightly higher Gran Tierra Energy (GTE) risk are Crown Point, President, Touchstone and Range. Ivanhoe Energy (IE) Madalena Energy (MVN) Cash flow dependence and LatAm independents Pacific Rubiales (PRE) Our analysis of markets lead us to four conclusions: 1) near-term cash flow Parex Resources (PXT) generation is currently the main driver of market value, with investors ascribing a Petroamerica Oil Corp (PTA) disproportionate emphasis to cash flow over exploration upside; 2) development Petrodorado Energy (PDQ) capital over the past year has largely focused on lower-risk regimes/ plays Petrominerales (PMG) (eg Llanos over the Southern Cone); 3) risk rankings and perception favour larger Platino Energy (PZE) and more established oils; and 4) the producer/developer model is likely to President Energy* (PPC) dominate in the near term although there are signs that this could change with Range Resources* (RRS) divestments, and new entrants are likely with the return of a bull market. Suroco Energy (SRN) Touchstone Exploration* (TAB) Are Colombia’s larger independents all priced in? *Edison Investment Research clients Colombia’s larger independents (EV>$500m) dominate trading volumes and lead valuations based on 2P reserves. Currently trading at EV/boe of US$28 per boe on Analysts a 2P basis, we see limited upside from current levels to their NPV10 average of Xavier M Grunauer +1 416 533 8223 US$29 per boe, signalling that growth will require new, powerful and unexpected catalysts. Featured companies that fall into this large, low risk, but lacking Ian McLelland +44 (0)20 3077 5756 significant catalysts category are Pacific Rubiales, Gran Tierra and Parex. Will Forbes +44 (0)20 3077 5749 Peter Dupont +44 (0)20 3077 5741 The Southern Cone is becoming more attractive Elaine Reynolds +44 (0)20 3077 5713 In contrast to Colombia’s larger independents, we find Southern Cone oils smaller Angus McPhail +44 (0)20 3077 5231 and, in general, delivering much lower netbacks. This said, impressive below- John Kidd +64 (0)4 8948 555 ground fundamentals and the region’s growing need for energy production are both [email protected] expected to drive change over the medium term. We find a combination of For institutional enquiries contact: conventional and unconventional assets, as well as what we expect will be improved realised pricing over the medium term, bodes well for this subset. Gareth Jones +44 (0)20 3077 5704 Featured companies that fall into this Southern Cone independent group are [email protected] GeoPark, Americas Petrogas, Crown Point, President and Madalena. www.edisoninvestmentresearch.com/research/team /resources-oil-gas Mid-tier shows us more potential to reveal value Finally, we also like Colombian mid-tiered independents currently trading at EV/boe of US$21 per boe on average, below their NPV10 of US$26 per boe. While riskier than their larger Colombian peers, we see upside in this subgroup based on their potential to grow production and prove up reserves over the medium term. Companies that fall into this category are Canacol, Petroamerica and Suroco. Contents Investment summary: Independents to lead growth 4 Challenging the status quo 4 Implications of our analysis and stock picks 4 Cash flow as the main driver of market value 5 Risk ranking favours larger oil companies 6 Lower-risk oils have outperformed (sort of) 6 LatAm oil and gas: A lay of the land 7 Access to LatAm reserves: Quite varied across the region 7 Value screen 1: Markets and 2P reserves 9 Cash is king in Latin America 9 Value screen 2: Quantifying risk 13 Risk takeaways 14 Value screen 3: Size and market performance 16 The US$500m and greater club 16 Emerging Latin American oil companies (less than US$500m, but greater than US$100m) 17 Proof of concept and exploration subset 17 Conclusions of our analysis 18 Near-term cash flow is a main driver of market value 18 Risk ranking favours Latin America’s larger oil companies 19 Subset of low-risk oils have outperformed (sort of) 20 Investment conclusions and stock picks 20 Are Colombia’s larger independents all priced in? 21 The Southern Cone is becoming more attractive 21 Mid-tier to show more potential to reveal value 21 LatAm country round-up 23 Colombia: Attractive fiscal terms 23 Argentina: Gas Plus programme a potential catalyst 24 Brazil: Leading the way, some mistakes along the way 25 Peru: Pushing beyond Camisea 26 Chile: A changing landscape 27 Trinidad: Encouraging further investment 28 Ecuador: A fixed fee structure 29 Paraguay: A new beginning 30 Venezuela: Moving beyond Chavez 31 Mexico: Potentially a net importer of oil 32 Appendix A: Risk ranking based on five criteria 33 Risk criteria 1: Management at the helm 33 Risk criteria 2: Country risk 33 Risk criteria 3: Financing/dilution risks 33 Fallen angels, rising stars | 10 October 2013 2 Risk criteria 4: Profitability of production 34 Risk criteria 5: Reserve replacement risk 35 Company profiles 36 Americas Petrogas 37 Amerisur Resources 39 Canacol Energy 41 Crown Point Energy 43 GeoPark 45 Gran Tierra Energy 47 Ivanhoe Energy 49 Madalena Energy 51 Pacific Rubiales 53 Parex Resources 55 Petroamerica Oil Corp 57 Petrodorado Energy 59 Petrominerales 61 Platino Energy 63 President Energy 65 Range Resources 67 Suroco Energy 69 Touchstone Exploration 71 Fallen angels, rising stars | 10 October 2013 3 Investment summary: Independents to lead growth Challenging the status quo While historically Latin American oil and gas production has been in the hands of national oil companies (NOCs) and large multinational oil and gas companies, a new production trend has been emerging. This new trend involves smaller independent E&P companies, which have brought capital and global experience to LatAm’s oil and gas basins resulting in what we expect will be mutual and sustainable advantages to all parties. These include: The ability to work smaller and marginal fields, some of which are not economic to larger oil companies or domestic NOCs with larger overheads. A higher tolerance for exploration risk and, as proven in North American unconventional basins, smaller independent E&P companies are much more likely to innovate and develop in situ technology. The accumulation of global conventional and unconventional operating experience, leading to a transfer of technology. Implications of our analysis and stock picks Our analysis of 18 independent LatAm oils concludes that the main driver of market value has been the ability to generate near-term cash flow. Ranking our universe on an EV/2P, we find the top half populated by Colombian oils, which is well correlated with our netback and cash flow ranking. In this report we introduce three valuation screens, based on cash flow, market value and risk, from which we segment our universe of 18 independent oil companies. Our top picks for the region are GeoPark, Americas Petrogas, Madalena, Canacol, Petroamerica and Suroco. Also seen as high potential but slightly higher risk are Crown Point, President, Touchstone and Range. Making use of risk, and cash flow screens, this report comes to the following five key macro conclusions: Colombian larger independents (EV>$500m) are currently trading at EV/boe of US$28 per boe on a 2P basis, near their NPV10 valuation average of US$29 per boe, potentially signalling markets that material upside from current levels will require significant catalysts. Featured companies that fall into this category are: Pacific Rubiales, Gran Tierra, Parex, Amerisur and Petrominerales, which has recently agreed to be purchased by Pacific Rubiales. Colombian smaller producing independents (EV<$500m) are currently trading at EV/boe of US$21 per boe on average, below their NPV10 of US$26 per boe and, while of higher volatility and risk profile, we see material upside in this this subgroup, based on their potential to prove- up operations and reserves over the medium term. Companies that fall into this category are: Canacol, Petroamerica and Suroco. Southern Cone independents in our universe are smaller in size than their Colombian peers, have lower netbacks, and in turn, lower EV on a 2P basis. But all these factors have a potential to change. Currently trading at EV/boe of US$18/boe as a group, a combination of conventional and unconventional reserves as well as what we expect will be improved realised pricing over the medium term all bode well for this subset. Featured companies that fall into this Southern Cone independent group are GeoPark, Americas Petrogas, Crown Point, President and Madalena. In Trinidad, we find a combination of proven and producing oil basins, low country risk, and the likelihood of further allowances in the current tax regime, to present an attractive combination. Currently realising EV/boe of US$6 per boe, and trading well below NPV10 of US$11 per boe, we see upside in this subgroup, which includes Touchstone and Range Resources. Fallen angels, rising stars | 10 October 2013 4 Finally, despite each carrying respectively attractive underlying acreage and upside potential, we are very cautious about Ivanhoe and Petrodorado, due to the uncertainties that each currently faces.